9

Market Power and Introduction 9

Chapter Outline 9.1 Sources of Power 9.2 and 9.3 Maximization for a Firm with Market Power 9.4 How a Firm with Market Power Reacts to Market Changes 9.5 The Winners and Losers from Market Power 9.6 Governments and Market Power: Regulation, Antitrust, and Innovation 9.7 Conclusion Introduction 9

In the real world, there are very few examples of perfectly competitive industries. Firms often have market power, or an ability to influence the market of a product. The most extreme example is a monopoly, or a market served by only one firm. • A monopolist is the sole supplier (and price setter) of a good in a market.

Firms with market power behave in different ways from those in perfect . Sources of Market Power 9.1

The key difference between and a in which firms have power is the presence of , or factors that prevent entry into the market with large producer surplus. • Normally, positive producer surplus in the long run will induce additional firms to enter the market until it is driven to zero. • The presence of barriers to entry means that firms in the market may be able to maintain positive producer surplus indefinitely. Sources of Market Power 9.1

Extreme Scale Economies: Natural Monopoly One common barrier to entry results from a process that exhibits at every quantity level • Long-run average total curve is downward sloping; diseconomies never emerge. Results in a natural monopoly: • It’s more efficient for a single firm to produce the entire industry . • Splitting output across multiple firms raises the of production. ‒ An example is a production process with the following structure: 100 TC 100 10Q  ATC  10 Q  What are some industries that might exhibit continuously declining average total as output increases? Sources of Market Power 9.1

Switching Costs Another barrier to entry results from the presence of consumers’ switching costs, which can result from • brand-related opportunity costs (e.g., preferred status on an airline). • technology constraints (e.g., software compatibility issues between Apple and Microsoft Windows–based operating systems). • search costs (e.g., health insurance plans).

Some have characteristics that make them network goods. • A good whose value to each consumer increases with the number of other consumers of the product  What are some network goods? ‒ Telecommunications ‒ Computer operating systems Sources of Market Power 9.1

Product Differentiation For most noncommodity markets, consumers may not treat products from different firms as perfect substitutes • Example: Burger King and Chipotle compete for fast-food customers, but their products are highly differentiated. How?

Product differentiation refers to imperfect substitutability across varieties of a product. Sources of Market Power 9.1

Absolute Cost Advantages or Control of Key Inputs Many production processes rely on scarce inputs (e.g., natural resource products). • Example: Saudi Aramco (Saudi Arabia’s state-run oil company) maintains control over a vast oil with relatively low extraction costs.

In other circumstances, firms may develop absolute cost advantages by engaging in long-term contracts with intermediate suppliers. • Apple has developed this type of relationship with Foxconn, a Chinese company that assembles many of Apple’s products. Sources of Market Power 9.1

Government Regulation A final important barrier is government regulation that limits entry to a market. • Examples: ‒ Patents ‒ Licensing requirements (e.g., medical board certification) ‒ Prohibition of competition (e.g., U.S. Postal ) Market Power and Marginal Revenue 9.2

A true monopolist faces the market curve: • There are no competing firms in this market. • Price is not fixed; the only way to sell more of a product is to lower the price.  How does this differ from perfect competition? ‒ Perfectly competitive firms can sell as much as they want at the market price. Other market structures associated with downward-sloping demand: • is a market structure in which a few competitors operate (e.g., the automobile industry) • is a market structure with a large number of firms selling differentiated products (e.g., the fast food industry) ‒ In these structures, the facing a given firm depends on the production decisions of other firms—strategic behavior, discussed further in the next chapter. Market Power and Marginal Revenue 9.2

Marginal Revenue In perfect competition, the demand curve facing an individual firm is horizontal, and marginal revenue is equal to price. If a firm has market power, the demand curve for its product(s) will have a downward slope.  What does this imply for the shape of the marginal revenue curve? ‒ It must also be downward sloping.

Consider the production decisions of Durkee-Mower, Inc., a Massachusetts firm that makes Marshmallow Fluff. • Has had a dominant market position since the 1920s • Table 9.1 shows how price and marginal revenue are related to the quantity of Fluff produced. Market Power and Marginal Revenue 9.2 Market Power and Marginal Revenue 9.2

Marginal revenue is not equivalent to price for a firm facing a downward- sloping demand curve.  Why is this the case? ‒ When a firm produces more of a product, the price for all of its products in the marketplace falls.

• This occurs because we are considering a specific market (time and place); decisions are not sequential, so firms cannot price-discriminate. • is a pricing strategy in which firms with market power charge different to different customers based on their willingness to pay. Market Power and Marginal Revenue 9.2

Marginal revenue is not equivalent to price for a firm facing a downward- sloping demand curve.

Marginal revenue is the change in total revenue associated with an increase in output, which is composed of two parts

Two components for a firm with market power 1. Increase in total revenue associated with an increase in sales 2. Decrease in total revenue associated with the fall in market price for all previously produced units of output Market Power and Marginal Revenue 9.2

Figure 9.1 Understanding Marginal Revenue

Price Revenue lost from increasing output Revenue unchanged

x P1 A y Revenue gained from P2 increasing output

B C

Demand Quantity Q1 Q2 Market Power and Marginal Revenue 9.2

The two opposing effects on marginal revenue of an increase in production by a monopolist can be examined mathematically:

1. The additional revenue from selling one more unit at market price DRevenue = P 2. The fall in revenue associated with a decline in market price for all units produced DP DRevenue = ´Q DQ Combining these effects gives the equation for marginal revenue: DP MR = P + ´Q DQ Market Power and Marginal Revenue 9.2

Consider what the equation for marginal revenue means DP MR = P + ´Q DQ

DP Consider a linear demand curve ( D Q is constant) The inverse demand curve is given by P = a - b Q ; therefore:

P P MR  P  Q  a  bQ Q  a  bQ  bQ  a  2bQ Q Q

MR  a  2bQ for a Firm with Market Power 9.3

How to Maximize Profit Firms with market power are still assumed to maximize profits. • However, unlike in perfect competition, production decisions influence price. MR ¹ P

How much will firms choose to produce? • They will engage in production until MR = MC

 Will a monopolist produce more or less than the aggregate production in an identical perfectly competitive industry? ‒ LESS! Profit Maximization for a Firm with Market Power 9.3

Profit Maximization: A Graphical Approach Consider the market for iPads; assume that the of production for Apple is constant at $200 per unit.

There are three steps to determining the profit-maximizing quantity of production: 1. Derive the marginal revenue curve from the demand curve. 2. Find the output quantity at which marginal revenue equals marginal cost. 3. Determine the profit-maximizing price by locating the point on the demand curve at the optimal quantity level. Profit Maximization for a Firm with Market Power 9.3

Figure 9.3 How a Firm with Market Power Maximizes Profit

Price ($/iPad) Profit is maximized when marginal revenue is equal to marginal cost. P * = $600

200 MC D

0 Q* = 80 Quantity of iPads MR (millions) Profit Maximization for a Firm with Market Power 9.3

Profit Maximization: A Mathematical Approach Consider again the market for iPads. The marginal cost of production for Apple is constant at $200 per unit. Now suppose demand is given by Q = 200-0.2P where quantity is measured in millions and price in dollars.

How do we determine the profit-maximizing price–quantity combination that Apple should choose? 1. Derive the marginal revenue curve from the demand curve. 2. Find the output quantity for which marginal revenue is equal to marginal cost. 3. Determine the profit-maximizing price by locating the point on the demand curve at the optimal quantity level. Profit Maximization for a Firm with Market Power 9.3

Profit Maximization: A Mathematical Approach 1. Derive the marginal revenue curve from the demand curve. Q = 200-0.2P 0.2PQPQ 200    1,000  5

This is a linear demand curve, so marginal revenue takes the form MR a 2 bQ  1,000  10 Q Profit Maximization for a Firm with Market Power 9.3

2. Find the output quantity for which marginal revenue is equal to marginal cost. For this step, simply set the equation for marginal revenue equal to $200 and solve for quantity. * MR  MC 1,000 10Q  200  Q  80 million

3. The profit-maximizing price can be found by substituting the profit- maximizing quantity into the inverse demand curve.

P* 1,000  5(80)  P*  $600 Profit Maximization for a Firm with Market Power 9.3

A Markup Formula for Companies with Market Power: The Lerner Index It is useful to have a general approach to determining the rate of markup for firms with market power. • Markup is the percentage of a firm’s price that is greater than its marginal cost. • The Lerner Index is a measure of a firm’s markup, which indicates the degree of market power the firm enjoys. Profit Maximization for a Firm with Market Power 9.3

A Markup Formula for Companies with Market Power: The Lerner Index Starting with the definition of marginal revenue and setting it equal to marginal cost, DP MR = P + ´Q = MC DQ Multiply the left-hand side by P/P (doesn’t change anything): DP P æ DP Qö P + ´ ´Q = P +ç ´ ÷´ P = MC DQ P èDQ P ø P - MC 1 1/Ed And finally, = - P E d or, as demand becomes more elastic, the optimal markup falls. Profit Maximization for a Firm with Market Power 9.3

A Markup Formula for Companies with Market Power: The Lerner Index

P - MC 1 Markup Rule: = - P E d

• Left-hand side is firm’s profit-maximizing markup, or the percentage of the firm’s price that is greater than (or marked up from) its marginal cost. • Indicates that as demand becomes more elastic, the optimal markup falls.  Why does this make sense? ‒ The more sensitive consumers are to price changes (more elastic) the less the firm can take advantage of them. How a Firm with Market Power Reacts to Market Changes 9.4

Response to a Change in Marginal Cost Just as in the case of a firm in a perfectly competitive industry, firms with market power will alter output decisions in response to changing marginal costs of production. Suppose an accident at the factory of an Apple parts supplier leads to an increase in the marginal cost of iPad production from $200 to $250 per unit.

How will this affect Apple’s production decisions? ‒ Marginal cost will increase, and because of the downward-sloping marginal revenue curve; the new optimal production should decrease. ‒ Price will also decrease as a result. How a Firm with Market Power Reacts to Market Changes 9.4

Figure 9.4 How a Firm with Market Power Reacts to an Increase in Marginal Cost

Price ($/iPad)

$1,000

d P2 = 625 b P1 = 600

c 250 MC2 200 a MC1 D MR 0 Q = 75 Q = 80 Quantity of iPads 2 1 (millions) How a Firm with Market Power Reacts to Market Changes 9.4

Response to a Change in Demand Now suppose there is an outward shift in the demand for iPads due to an expansion of their use by the medical industry. The new demand curve is given by Q  280  0.2P

The new inverse demand curve is given by P 1,400  5Q

To find the new profit-maximizing price–quantity combination, follow the same three-step procedure. How a Firm with Market Power Reacts to Market Changes 9.4

Response to a Change in Demand 1. Derive the marginal revenue curve from the inverse demand curve. P 1,400  5Q Marginal revenue takes the form

MR  a  2bQ  MR 1,400 10Q

2. Find the output quantity for which marginal revenue is equal to marginal cost.

MR  MC 1,400 10Q  200  Q* 1.2 million How a Firm with Market Power Reacts to Market Changes 9.4

Response to a Change in Demand 3. The profit-maximizing price can be found by substituting the profit- maximizing quantity into the inverse demand curve.

P 1,400  5(120)  $800

So an outward shift in demand increases both the quantity of iPads produced and the price at which each is sold. How a Firm with Market Power Reacts to Market Changes 9.4

Changing the Price Sensitivity of Consumers A major way in which firms with market power react differently from those subject to perfect competition is in response to changes in the price sensitivity of demand.

For instance, consider what happened to the demand for iPads when Amazon introduced its Kindle Fire tablet computer. • Demand for iPads should have become more price-elastic. • The demand curve for iPads should have had a shallower slope. How a Firm with Market Power Reacts to Market Changes 9.4

Figure 9.5 Responses to a Rotation in the Demand Curve

(a) Perfect competition (b) Market power

Price Price ( $/unit) ( $/unit) S MC

D2 D2

D1 MR1 MR2 D1 Quantity Quantity Qc* In perfect competition the shape of the demand curve does not matter; only the intersection with the supply curve. The Winners and Losers of Market Power 9.5

If firms with market power find it profitable to choose a level of output that is different from what would occur in perfect competition, there must be some additional benefit.

 How much better off are firms when they have market power, and what does this imply for consumers’ well-being? ‒ Examine Producer and Consumer Surplus to see! The Winners and Losers of Market Power 9.5

Consumer and Producer Surplus under Market Power Returning to the example of Apple and the iPad, recall that Apple has a marginal cost of production of $200 per unit and faces inverse demand: PQ1,000 5 where quantity is measured in millions.

Producer surplus is the difference between the monopoly price of iPads and the constant marginal cost, multiplied by the quantity sold.

PS = (Pm - MC)´Qm = ($600-$200) ´80 million = $32 billion The Winners and Losers of Market Power 9.5

Consumer and Producer Surplus under Market Power Consumer surplus is calculated as the area under the inverse demand curve and above the sales price.

First, calculate the demand choke price, which is the price at which quantity demanded is equal to zero. P 1,000  5 0  $1,000 With linear demand, consumer surplus is a right triangle with height equal to the demand choke price net of the sales price and length equal to quantity sold. 11 CS P  P  Q $1,000  $600  $80 million  $16 billion 22choke mm The Winners and Losers of Market Power 9.5

Consumer and Producer Surplus under Perfect Competition How would the outcome of the market for iPads change under perfect competition? In perfect competition, marginal cost is equal to industry supply, and equilibrium occurs when industry supply is equal to demand. P MC 1,000  5 Q  200  Q  160 million and price is equal to $200.

 What happens to Apple’s producer surplus? ‒ It equals zero in perfect competition because P = MC. Consumer surplus becomes 11 CS P  P  Q $1,000  $200  160 million  $64 billion 22choke cc The Winners and Losers of Market Power 9.5

Figure 9.6 Surplus from the Apple iPad

Price Consumer surplus (competition) = A+ B + C ($/iPad) Producer surplus (competition) = 0 Consumer surplus (market power) = A $1,000 Producer surplus (market power) = B from market power = C

A Market power, m Pm = 600

Competition, c B C

Pc = 200 MC D

0 Q = 80 Q = 160 Quantity of iPads m c (millions) The Winners and Losers of Market Power 9.5

The Deadweight Loss of Market Power Producer surplus is eliminated under perfect competition, but consumer surplus increases. Also, net surplus improves under perfect competition, from $48 billion to $64 billion. This illustrates the loss in efficiency in markets that are not perfectly competitive. • When producers have market power, they can improve overall outcomes. • However, if producers reduce output to a level below the perfectly competitive level, total surplus falls. This loss of efficiency is a deadweight loss, and in this case it is equal to $16 billion. The Winners and Losers of Market Power 9.5

Figure 9.7 Gains from Market Power under Different Demand Curves

(a) Less elastic demand (b) More elastic demand

Price Price ( $/unit) ( $/unit)

P1

PS1 P2 PS2 MC MC

MR D MR1 D1 2 2 Quantity Quantity Qm Qm Governments and Market Power: Regulation, Antitrust, and Innovation 9.6

The deadweight loss associated with market power can justify government intervention if regulations help achieve a more competitive or efficient outcome. Direct Price Regulation In some cases, the government will regulate price rather than attempting to dismantle a monopoly or encourage new participants. • This is often the case for natural , or industries in which a firm’s long-run average total cost falls continuously as output increases. Consider a that provides electricity to a town. • Significant fixed costs (generation and transmission) • Low marginal costs Governments and Market Power: Regulation, Antitrust, and Innovation 9.6

Figure 9.8 Government Regulation of a Natural Monopoly

Price ($/kwh) What happens if a regulator forces the utility to provide the “efficient” level of electricity (where LMC = demand)?

A m Pm

B LATC C P c c LMC MR D

Q Q Quantity of m c electricity (millions of kilowatt-hours) Governments and Market Power: Regulation, Antitrust, and Innovation 9.6

Antitrust laws are designed to promote competitive markets by restricting behaviors that limit competition • Mergers and acquisitions • and other forms of • Can be difficult to determine if concentration is bad for consumers

In other cases, the government may actually promote monopolies. • Patents, licenses, copyrights ‒ Designed to spur innovation ‒ In setting length of patents, must balance the incentive for innovation with the reduction in consumer welfare that comes with granting a monopoly. Rent-seeking is a firm’s attempts to gain government-granted monopoly power and therefore additional producer surplus. Conclusion 9.7

In this chapter, we have shown how firms with market power don’t treat output price as fixed but instead recognize that price depends on the quantity produced. • Firms produce where marginal cost is equal to marginal revenue. • Equilibrium output is lower than under perfect competition. • Market power leads to a deadweight loss.

However, we have so far assumed that to sell more of a product, a firm must lower the price on all previously produced units. In Chapter 10, we examine how firms may be able to charge different prices to different consumers, a practice called price discrimination. In-text figure it out

Suppose the demand for a product is given by Q 12.5  0.25P

Answer the following questions: a. Find the marginal revenue curve associated with this demand curve. b. Calculate marginal revenue when the firm produces six and seven units of output, respectively. In-text figure it out a. First, solve for the inverse demand curve. Q 12.5 .25P 0.25P 12.5  Q  P  50  4Q The equation for the marginal revenue for a linear demand curve is MR  a  2bQ MR  50  24Q  50  8Q b. Plugging in Q = 6 to the marginal revenue equation yields MR  50  86  2 and Q = 7 yields MR  50  87  6

As output increases, marginal revenue falls, and eventually producing more will result in lower total revenue. Additional figure it out

Suppose the demand for a product is given by Q =16 - 0.5P

Answer the following questions: a. Find the marginal revenue curve associated with this demand curve. b. Calculate marginal revenue when the firm produces three and five units of output, respectively. Additional figure it out a. First, solve for the inverse demand curve. QP16 0.5 0.5P 16  Q  P  32  2Q The equation for the marginal revenue for a linear demand curve is MR = a -2bQ MR  32  22Q  32  4Q b. Plugging Q = 3 in to the marginal revenue equation yields MR  32  43  20 and Q = 5 yields MR  32  45 12

As output increases, marginal revenue falls, and eventually, producing more will result in lower total revenue In-text figure it out

Babe’s Bats (BB) sells baseball bats for children around the world. The firm faces a demand curve of 푸 = ퟏퟎ − ퟎ. ퟒ푷, where Q is measured in thousands of bats and P is dollars per bat. BB has a marginal equal to 푴푪 = ퟓ푸.

Answer the following questions: a. What is BB’s profit-maximizing output? Show the profit- maximizing decision graphically. b. What price will BB charge to maximize its profits? In-text figure it out a. To solve, follow the three-step procedure outlined previously.

First, derive the marginal revenue curve for BB Bats. QP10 0.4 0.4PQ 10   P  25  2.5Q

This is a linear demand curve, so marginal revenue takes the form

MR  a  2bQ  MR  25  5Q

Second, find the output quantity for which marginal revenue is equal to marginal cost. MR  MC  25  5Q  5Q  Q*  2.5

The profit-maximizing output for BB’s bats is therefore 2,500 bats. In-text figure it out

Graphically

b. To solve for the optimal price, plug in the profit-maximizing level of output to the inverse demand curve.

P*  25  2.5(2.5)  P* 18.75 In-text figure it out

The Power Tires Company has market power and faces the demand curve shown in the figure. The firm’s marginal cost curve is

MC  30  3Q

Answer the following questions: a. What are the firm’s profit-maximizing output and price? b. If the firm’s demand declines to P = 240 – 2Q, what is the firm’s profit- maximizing level of output and price? How does this compare to your answer to question a? c. Draw a diagram showing these two outcomes. Holding marginal cost equal, how does the shape of the demand curve affect the firm's ability to charge a higher price? In-text figure it out a. First, use the graph to find the equation for the inverse demand curve.

P  a  bQ

 300  P  300   Q  100 

P  300  3Q

Next, find the marginal revenue curve using the inverse demand curve. MR  a  2bQ  MR  300  2(3)Q

MR  300  6Q In-text figure it out

Profit maximization occurs where MR = MC, or 300  6Q  30  3Q  270  9Q  Q*  30 And the price

P  300  3Q  300  3(30)  P*  $210 b. When demand falls to P = 240 – 2Q, we have a new MR curve, MR  240  2(2)Q  240  4Q Following a similar process as before, * MR  MC  240  4Q  30  3Q  Q  30 P*  240  2(30)  P* 180

The profit-maximizing quantity is the same, but the price is lower. In-text figure it out

c. Graphing the outcomes from a and b,

Price ( $/tire) MC  30  3Q MC 300 Demand and marginal revenue from a. 240 210 D  P  300  3Q 180 MR  P  300  6Q

Demand and marginal revenue from b. D  P  240  2Q MR  P  240  4Q 30 D2 MR1 MR2 D1

30 50 60 100 120 Quantity of tires (thousands)

Because D2 is flatter, the firm must charge a lower price, as consumers are more responsive to price changes. Copyright © 2013 Worth Publishers, All Rights Reserved   Goolsbee/Levitt/ Syverson 1/e Additional figure it out

Suppose the local roofing company has market power and faces the following inverse demand curve: PQ2,000 10 where quantity is the number of roof jobs and price is in dollars. The marginal cost for this firm is MC = 200+16Q

Answer the following questions: a. What are the profit-maximizing output and price? b. If the firm’s demand declines to PQ1,400 12 , what are the new profit-maximizing output and price? Additional figure it out a. First, derive the marginal revenue curve from the inverse demand curve. PQ2,000 10

Marginal revenue takes the form MR  a  2bQ  MR  2,000  20Q

Setting marginal cost equal to marginal revenue, MR  MC  2,000  20Q  200 16Q  Q*  50

So the profit-maximizing quantity is 50 roofing jobs. To find the price, use the inverse demand curve. P*  2,000 10(50)  P* 1,500

The profit-maximizing price is $1,500 per roof. Additional figure it out b. Now, perform the same calculations with the new inverse demand curve. PQ1,400 12 Marginal revenue is MR a 2 bQ  1,400  24 Q Setting marginal cost equal to marginal revenue, MR  MC 1,400  24Q  200 16Q  Q*  30

The profit-maximizing quantity is 30 roofings, and there has been a reduction in demand. Using the inverse demand curve, P* 1,4000 12(30)  P* 1,040

And the profit-maximizing price is $1,040 per roof. In-text figure it out

Recall that Babe’s Bats faces an inverse demand curve of P = 25-2.5Q and marginal cost curve MC = 5Q, where quantity is measured in thousands of bats and price in dollars.

Calculate the deadweight loss from market power at the firm’s profit-maximizing level of output. In-text figure it out

The easiest way to find deadweight loss is through the use of a diagram.

Price Consumer surplus (competition) = A+ B + C ($/bat) Producer surplus (competition) = D+E+F Consumer surplus (market power) = A $25 Producer surplus (market power) = B+D+F Deadweight loss from market power = C+E

A Market power, m 18.75 Competition, c MC B C 16.68 D E 12.5 F MR D 0 Q = 2.5 Q = 3.33 Quantity of bats m c (per day) In-text figure it out

Mathematically Recall that the profit-maximizing level of output is 2,500 bats sold at a price of $18.75. To find the deadweight loss, consider producer and consumer surplus and compare them with the competitive outcome. If BB were in a competitive market, it would set marginal cost equal to price.

P  MC 25  2.5Q  5Q Q*  3.33 The perfectly competitive output for BBs is 3,330 thousand bats. To find the perfectly competitive price, plug this in to the inverse demand curve.

P  25  2.5(3.33)  P* 16.68 In-text figure it out

The profit-maximizing level of output for BB is 2,500 bats per day at a price of $18.75 per bat. If BB were operating in a competitive market, it would offer 3,330 bats per day at $16.68 per bat.

The deadweight loss associated with market power is equal to the difference in total surplus between the competitive and monopoly conditions.

In this example, you can use the formula to calculate the loss from the graph. 1 DWLAreas C  E  × Base × Height 2 1 DWL   (18.75 12.50) (3.33  2.5)  $2.59375 2

Since quantity is measured in thousands, deadweight loss is equal to $2,593.75. Additional figure it out

Joe’s Garage (JG) faces inverse demand curve P = 120 – 10Q and marginal cost curve MC = 20, where quantity is measured in rotations per day and price in dollars.

Calculate the deadweight loss from market power at the firm’s profit-maximizing level of output. Additional figure it out

The easiest way to find deadweight loss is with a diagram.

Price Consumer surplus (competition) = A+ B + C ($/rotation) Producer surplus (competition) = 0 Consumer surplus (market power) = A $120 Producer surplus (market power) = B Deadweight loss from market power = C

A Market power, m Pm = 70

Competition, c B C

Pc = 20 MC MR D

0 Q = 5 Q = 10 Quantity of rotations m c (per day) Additional figure it out

Mathematically The profit-maximizing output and price can be found by setting MR equal to MC.

First, find the MR curve from the inverse demand curve P = 120 − 10Q. MR  a  2bQ  MR 120  20Q

Solving for the profit-maximizing output and price, MR  MC 120  20Q  20  Q*  5

P 120 10(5)  P*  70

In perfect competition, the firm will set P = MC.

Pc  20  20 120 10Q  Qc 10 Additional figure it out

The profit-maximizing level of output for JG is 5 rotations per day at a price of $70 per rotation. If JG were operating in a competitive market, it would offer 10 rotations per day at $20 per rotation (price equal to marginal cost).

The deadweight loss associated with market power is equal to the difference in total surplus between the competitive and monopoly conditions.

In this example, it is a right triangle with length of 5 and height of 50.

1 DWLArea C × Base × Height 2 1 DWL   (10  5) (70  20)  $125 2